Brown Brothers on Munis: Steady Fundamentals But Tough To Find New Bonds

By Michael Aneiro

BBH likes credits that aren’t directly tied to the actions of policy makers, which aren’t easy to predict, and prefers to analyze “essential service entities whose operations we can review much like we would a business, assessing their financial condition through the strength and sustainability of their revenue sources and the need for their services.” Currently on that front, BBH likes selective healthcare-related credits, airports and industrial revenue bonds, and also sees value in structured securities such as floating rate-notes, callable debt, and auction-rate securities.

Here’s BBH on the impact of rising rates:

We expect the inevitable increase in rates to be gradual, and concentrated in longer maturities over the next several years. According to our calculations, the price impact of a gradual yield curve steepening resulting from higher long-maturity rates will be largely offset by income and the favorable impact of yield curve roll down, or the price appreciation associated with a security aging along the positively-sloped yield curve. As a result, we expect fairly modest municipal bond portfolio returns in the low single digits over the next few years.

BBH also says that until recently it had little trouble identifying “a wide range of durable municipal credits, particularly revenue issuers, at attractive valuations,” but that buying new bonds “has proven to be a greater challenge as spreads and rates have been materially contracting.” More from BBH:

[W]hen we cannot source attractively-priced opportunities, we place our client’s assets in liquid reserves. Presently, our core municipal portfolios maintain reserve positions at 12%. In the meantime, we remain cautiously optimistic for continued improvements in the U.S. economy and subsequently, municipal fundamentals. We expect to maintain significant concentrations to revenue bonds and structured securities in our client portfolios.

Amey Stone is Barron’s Income Investing blogger and Current Yield columnist. She was formerly a managing editor at CBS MoneyWatch, MSN Money and AOL DailyFinance. Her responsibilities included overseeing market coverage and personal finance topics. Prior to those roles, she was a senior writer at BusinessWeek where she authored the Street Wise column online and contributed to the magazine’s Inside Wall Street column. Topics covered included economics, corporate finance, Fed policy, municipal bonds, mutual funds and dividend investing. She co-authored King of Capital, a biography of Citigroup Chairman Sandy Weill. She is a graduate of Yale University and Columbia University’s Graduate School of Journalism.